Maxim analyst Jason McCarthy sees nothing but blue sky for Stellar Biotechnologies Inc., even though its product originated in the deep blue sea. With blockbuster indications like cancer, lupus and Alzheimer's disease being targeted by partners, and a manufacturing process sure to satisfy regulators, McCarthy lays out a value proposition for Stellar's KLH that investors should not ignore.

The Life Sciences Report: You cover Stellar Biotechnologies Inc. (SBOT:NASDAQ) with a target price of $17/share, which represents more than a fourfold increase over the stock's current valuation, at ~$3.50/share. What's the value proposition you see here?

Jason McCarthy: Given the current bear market—the correction we've seen over the last six months in the biotech markets—we believe the stock is artificially depressed, like most of biotech right now. The stock was closer to $7–8/share not long ago.

The value proposition revolves around what Stellar's partners are doing. The company has key partnerships, including one with Neovacs SA (ALNEV:Alternext Paris), a French company working on systemic lupus. It also has a partner in OBI Pharma Inc. (4174:Taipei) in China, which is working in breast cancer. OBI recently presented promising data from a Phase 2b study demonstrating statistically significant improvements in progression-free survival and overall survival in women that generated immune responses from OBI's keyhole limpet hemocyanin (KLH)-based vaccine. A Phase 3 study is now being planned. In addition, Stellar has undisclosed partners working in Alzheimer's disease, as well as other undisclosed oncology and autoimmune indications.

"Stellar's KLH is a part of what could be blockbuster vaccines."

What drives biotech is data: data showing definitive proof of concept, data from a Phase 3 study that moves a therapy closer to a biologic license application, a new drug application filing or drug approval. When you see these successes from biotech companies, you often see valuation inflection.

Though Stellar is not specifically making vaccines, its KLH is a part of what could be blockbuster vaccines that are currently in proof-of-concept studies. If one of these vaccines is successful, that's a reflection on Stellar. We believe the company stands to be the beneficiary of a successful vaccine from the point of view of KLH supply. Its valuation should flow hand-in-hand with the successes of its partners.

TLSR: Can you discuss some of the programs that Stellar is working on in conjunction with its partner companies?

JM: OBI is doing work in metastatic breast cancer. The whole idea of KLH is that it drives what I believe are antibody-biased responses. With KHL-based vaccines, you can also see significant T-cell responses. What OBI found in breast cancer patients with metastatic disease is that some patients developed significant antibody titers targeting globo H, which is the antigen it made the KLH vaccine with. There was a statistically significant improvement in progression-free survival, as well as overall survival.

This testing took place in China, and there are still a lot of things that have to happen in the U.S. and in Europe before investors really take note. I think people didn't pay attention to this data, but to us it was a significant result. It is suggestive that a KLH-based immunotherapy could work in breast cancer, and we're curious to see where OBI Pharma takes this. The benefit to Stellar is that it is going to keep supplying OBI's KLH.

TLSR: What sets Stellar's KLH apart from the competition?

JM: Stellar's KLH is the only quality KLH that meets the standards for general manufacturing practices (GMP) grade. You can get lot-to-lot consistency such that you can actually make a vaccine that regulators could find suitable for approval. That's the difference. If one of Stellar's partner companies is successful, it would likely have to continue to use Stellar's KLH. It has to use the same product it used to get through its clinical studies.

The competition, to our knowledge, can't develop such a consistent KLH product. Stellar is the only company that has on-land aquaculture that houses and grows keyhole limpets, which is actually an animal. Thus, Stellar has a very defined population of keyohole limpets. The company is controlling the water environment, the nutrients the limpets are receiving. It is harvesting with very specific protocols, only at certain times a year, only a certain amount of KLH per animal.

"With KHL-based vaccines, you can also see significant T-cell responses."

Other KLH manufacturers have to go to the Channel Islands in California, which is the only place keyhole limpets grow, to harvest the animals off the bottom of the ocean. Most people would say there's inconsistency there. Even though the manufacturing process may be on par with what Stellar is doing, these companies have no idea what's really happening in the ocean on a day-to-day basis. That's the major difference between Stellar and any competitors in the KLH space.

TLSR: Does Stellar have an advantage in terms of cost because it is raising these animals in a facility as opposed to having to go out to the Channel Islands to harvest them?

JM: Stellar has a cost advantage in that, since the company raises the animals, it can manufacture in bulk. Having the manufacturing capability to meet kilograms and kilograms of demand (KLH protein) mitigates some costs associated with the aquaculture facility. . .supply and demand.

Overall, I think Stellar's net margin is reasonable. We project the company's cost of goods to be only about 35%, which a 65% margin—not as great as pharmaceutical margins at 80–90%, but better than where a biologic would be, like a checkpoint antibody or a chimeric antigen receptor (CAR) T-cell. We think Stellar has a viable commercial business.

TLSR: Let's talk about Michael Robinson. Earlier this year, he put a Sell on the stock to his subscribers who'd bought the stock higher. He said that, fundamentally, he still liked the stock but that he saw other short-term opportunities. Would you comment?

JM: Michael Robinson did his own research and I'm sure had his reasons to move to a Sell. But I think you need to look at the totality of what Stellar is doing. You have to look beyond the reason its sales are not so impressive right now. You need to look at Stellar as a pure biotech. You need to look at it like the immunotherapy space, which is getting hot. Look at Kite Pharma (KITE:NASDAQ). Look at Juno Therapeutics (JUNO:NASDAQ).

We recommend Stellar with a Buy rating. Its partners are developing immunotherapies and vaccines using KLH in potentially blockbuster indications. OBI Pharma is doing well with its KLH vaccine, and Neovacs is doing well with its vaccine in lupus. Investors should think of Stellar in terms of finding the major tipping point for the company, which is where the valuation inflection will come from. We think it's when the company's partners are successful, and in biotech there are ways to determine when that may be. When you see valuation suppressed or dropping off—it could be from a lot of reasons—you need to look at the big picture. Given the opportunity that OBI has—or anybody in the KLH immunotherapy space has—the upside is significant, in our opinion. With the valuation suppressed, which in our view is due, in part, to a bearish biotech market, we see a buying opportunity.

I think KLH is becoming the base for a new arm of the immunotherapy space. MabVax Therapeutics Inc. (MBVX:OTCQB), a micro-cap company, is developing monoclonal antibodies through Memorial Sloan Kettering Cancer Center. If I remember correctly, MabVax is picking out antibodies to develop using a KLH-based vaccine. KLH-based vaccines may be more successful where an antibody response may be more highly desired.

TLSR: When I think about vaccines, I think of an active ingredient in an inert serum. It sounds like KLH is more of an active ingredient.

JM: It is. This has been known for a long time, and goes back many years in academia. We have been using KLH as a carrier protein. There are a lot of molecules out there—proteins, small molecules, for me it happened to be a toxin—that you can't inject into an animal or human to make an antibody response or an immune response of any kind (i.e., cell-based). If you took interferon, or if you took TNF alpha or another cytokine, and you tried to inactivate it and vaccinate with it alone, it wouldn't really generate much of an immune response. It just wouldn't work. The immune system wouldn't "see" it. You need something to carry it in and show it to the immune system.

"KLH is becoming the base for a new arm of the immunotherapy space."

People use different kinds of carrier proteins. KLH happens to be one of the more popular because it is immune stimulatory on its own. With KLH, you can bring in the antigen you want a response to, plus get a kick in the rear end of the immune system by KLH itself. KLH ends up playing an active role. You have to use the KLH conjugate to get the immune response. It's a potent immune stimulator, and for that reason, it's desirable.

Don't think of it as a vaccine—think of it as an active immunotherapy. You inject your patients however many times per year, and they're generating responses and it's maintaining their diseases or controlling their diseases. That's a better way to think about it.

TLSR: Can you talk about market opportunity for KLH?

JM: My understanding is that Stellar will probably target some sort of partnership or supply contract, or even a royalty on a vaccine as the KLH supplier. The company hasn't stated that publicly; that's what we believe could happen.

As far as market opportunity is concerned, let's take breast cancer as an example. A population of 240,000 (240K) women are diagnosed every year in the U.S. alone. Many more are survivors or are living with breast cancer. If 30% of those patients take a KLH vaccine, that's an addressable population of ~80K. You need at least 1 kilogram (1 kg)—and up to 3 kg—of KLH for the vaccine. With bulk pricing at that volume near ~$30,000/gram, that's a significant amount of money. And that's just for one vaccine. If you need to make 80K doses of a vaccine, and you need 1 kg for each dose, you probably need three or four times that amount of KLH because you have to assume you're going to lose a lot in the manufacturing process.

That's where we see the big swing in Stellar's manufacturing and supply. The question is: When does one of its partners, like OBI, get there?

That's also why we consider these to be blockbuster indications. If you're going to make a vaccine for 80K people, you need quite a lot of KLH. And you know what? You can't just get it from harvesting off the ocean floor. The FDA, China's regulatory agency and the European Medicines Agency won't allow that. They want a patented, GMP-quality KLH, and to our knowledge, only Stellar can provide that.

TLSR: Do you have any final thoughts on Stellar you'd like to share with investors?

JM: I think the immunotherapy space has been dominated on the oncology side in recent years by the T-cell first movers, the Kites and the Junos, and even bluebird bio Inc. (BLUE:NASDAQ) now, and Novartis AG (NVS:NYSE).

But there's a whole other world on the vaccine side that's significantly undervalued, in our opinion—companies like Bavarian Nordic (BAVA:OMX) and Galena Biopharma Inc. (GALE:NASDAQ), working in prostate cancer and breast cancer, respectively. Stellar's partners are making KLH-based vaccines, and they too are undervalued, in our view.

We see KLH as up and coming on the vaccine side, and see many groups in the space focused on cell-based vaccines, so there's an opportunity there. The infectious disease side—a side of the vaccine immunotherapy world that is also undervalued, in our opinion—could also benefit from KLH because KLH can drive significant antibody responses, which is critical for fighting infectious disease, whether bacterial or viral. As you watch the immunotherapy space continue to spiral upward, KLH is going to come forward as a new player in the space.

TLSR: Jason, I appreciate your time.

Jason McCarthy, Ph.D., is an equity research analyst covering the biotechnology industry at Maxim Group. McCarthy joined Maxim Group in July 2014. Prior to joining Maxim he received his doctoral degree in biomedical sciences from the Albert Einstein College of Medicine. McCarthy also holds master's degrees in both biomedical research (Albert Einstein College of Medicine) and molecular biology (Adelphi University), as well as a bachelor's degree in biochemistry from Stony Brook University. He closely follows gene therapy, CAR-T and the cancer immunology spaces, as well as many traditional biotechnology companies.

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Disclosure:
1) Tracy Salcedo conducted this interview for Streetwise Reports LLC and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) Stellar Biotherapeutics Inc. is a billboard advertiser with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services. Click here for important disclaimers. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
3) Dr. Jason McCarthy: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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